October 16, Colombo (LNW): Sri Lanka’s financial system is on the path to improvement, with expectations of enhanced asset quality and stronger capital buffers, according to the Central Bank of Sri Lanka (CBSL) in its Financial Stability Review 2024.
As the economy stabilizes, despite lingering challenges, efforts to correct macrofinancial imbalances are showing results, driven by policy measures and reforms that support financial stability.
The CBSL praised the financial sector’s progress in managing the effects of the economic crisis but emphasized the importance of sustained efforts to ensure stability in the medium to long term.
Since April 2022, Sri Lanka’s banking system, including the central bank, has repaid or built reserves of $7.39 billion, despite implementing deflationary policies and selective defaults on certain debts.
While challenges like high non-performing loan (NPL) ratios, deposit mobilization issues, and reduced net interest income persist, the CBSL highlighted the need for continued proactive risk management.
It stressed the significance of maintaining balanced external demand, stable prices, and fiscal consolidation to foster sustained economic growth.
The completion of external debt restructuring is expected to pave the way for new financial resources, albeit with a cautious approach.
As the credit cycle expands, the CBSL will closely monitor systemic risks, recommending measures to ensure ongoing financial stability and calling for commitment to reforms from all stakeholders.
However, as credit expands into the private sector, financial institutions will need to manage pressures on credit quality and capital adequacy, especially given high non-performing loan (NPL) ratios and caps on large exposures, CBSL cautioned.
Attracting deposits amid low rates remains a challenge, while falling lending rates could squeeze net interest income and profitability. Sovereign exposure, particularly in government securities, which generated significant returns recently, may also decline, the bank warned.
The CBSL added that adjustments in the external and fiscal sectors, including suppressed import demand and delays in meeting sovereign debt obligations, must be handled carefully to ensure financial stability.
Nevertheless, the completion of external debt restructuring will open the door to further external financial resources, albeit prudently.
“Challenges will persist as the benefits experienced through the recovery in macrofinancial conditions, supported by the favourable base effect, diminish,” the CBSL noted, adding that the outlook depends on sustained fiscal consolidation, balanced external demand, and stable prices to foster economic expansion.
With higher risk-taking expected during the credit cycle’s expansion, vulnerabilities may build, underscoring the need for proactive risk management, CBSL said.
As the macroprudential authority, the CBSL, along with the Financial System Oversight Committee, will continue to monitor systemic risks and recommend policy measures to ensure financial stability. It called on all stakeholders to remain committed to timely, well-sequenced reforms for sustained stability.
